The Home and Automobile Decision

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Learning Objectives

1. Make good buying decisions.

2. Choose a vehicle that suits your needs and budget.

3. Choose housing that meets your needs.

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Learning Objectives

4. Decide whether to rent or buy housing.

5. Calculate the costs of buying a home.

6. Get the most out of your mortgage.

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Introduction

Buying a home is the single biggest investment most people will make.

Buying a car is another major purchasing decision.

Must fit lifestyle and wallet.

Probably need a loan making dramatic impact on personal finances.

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Smart Buying

Step 1: Differentiate Want From Need

Step 2: Do Your Homework

Step 3: Make Your Purchase

Step 4: Maintain Your Purchase

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Smart Buying in Action:Buying a Vehicle

Choices to consider:

Buy new

Buy used

Leasing

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Smart Buying in Action:Buying a Vehicle

Step 1: Differentiate Want From Need

Features and qualities wanted

Features and qualities needed

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Smart Buying in Action:Buying a Vehicle

Step 2: Do Your HomeworkHow much can you afford?

Down paymentMonthly payment

Which vehicle is right for you?Comparison shop—price and attributesOperating and insurance costs, and

warranty.

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Smart Buying in Action:Buying a Vehicle

Step 3: Make Your Purchase

Get a fair price:Know the dealer cost or invoice price.Dealer holdback—2 to 3% that

manufacture gives the dealer on the sale of an automobile

Approach dealers and get quotesNegotiate

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Smart Buying in Action:Buying a Vehicle

Step 3: Make Your Purchase

Financing Alternatives:Cheapest—cash Investigate all financing options before

buying.Keep financing out of the negotiations.The shorter the term, the higher the

monthly payments.

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Smart Buying in Action:Buying a Vehicle

Step 3: Make Your Purchase

Leasing: ideal for financially stable, want new car every few years, drive less than 15,000 miles annually, good credit, no down paymentClosed-end or walk-away leasePurchase optionOpen-end lease

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Smart Buying in Action:Buying a Vehicle

Step 3: Make Your Purchase

Keys to getting a good lease:Negotiate value for car before signing leaseMinimum down paymentWarranty—define “normal wear and tear”Termination feeDepreciation factorRent or finance charge

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Smart Buying in Action:Buying a Vehicle

Step 4: Maintain Your Purchase

Keep vehicle in best running condition.

Don’t ignore signs of trouble.

Your first line of protection is the warranty.

Know your rights under the Lemon laws.

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Smart Buying in Action: HousingMany people equate home ownership with

financial success.

Housing costs can take up over 25% of after-tax income.

Home ownership is also an investment – biggest investment you will ever make.

Use smart-buying approach.

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Your Housing Options

A House:Most potential for capital appreciation.

Cooperatives and Condominiums:Homeowner’s feePlanned unit developments

Apartments and other rental housing

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Smart Buying in Action: HousingStep 1: Differentiate Want From Need

What about the house is important?

Know what you want before you look.

Affordability, location, neighborhood, conveniences, schools

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Smart Buying in Action: HousingStep 2: Do Your Homework

Investigate the potential home and all that goes along with it:Neighborhood, community lifestyle,

satisfy needs.

How much you can afford to pay?

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Smart Buying in Action: Housing

One-time Costs:Down payment Closing/settlement costs

PointsLoan origination feeApplication feeAppraisal feeTitle search fee

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Smart Buying in Action: Housing

Recurring Costs Monthly mortgage payments PITI

Maintenance and Operating Costs:repairs, renovations, upgrades,

landscaping

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Renting Versus Buying

Decision based on lifestyle

Renting advantages: Financial and lifestyle flexibility

Compare costs for each alternative

Buying advantages:Longer stay and appreciation, itemized

taxes, forced savings

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Determining What YouCan Afford

What is the maximum amount the bank will lend me?Financial historyAbility to payAppraised home value

Calculating your mortgage limitShould I borrow up to this maximum?How big a down payment can I afford?

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Financing the Purchase—The Mortgage

Sources of mortgages:S&Ls and commercial banksCredit unions, mutual savings banksMortgage bankers—originate mortgage

loans, sell to banks, pension funds, insurance companies and collect payments

Mortgage brokers—middlemen comparison shop for a fee to secure mortgage loans for borrowers but do not originate the loans

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Conventional and Government-Backed Mortgages

Conventional loans—from a bank or S&L secured by the property.

Government-backed loans—loan from traditional lender but insured by government—FHA and VA loans: lower interest rate, smaller down

payment, less strict financial requirements

more paperwork, higher closing costs, limited funding

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Fixed-Rate MortgagesMonthly payment doesn’t change

regardless of market interest rate changes.

Can lock in low rates for the life of the loan.

An assumable loan can be transferred to a new buyer.

Prepayment privilege allows early cash payments to be applied to principal.

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Adjustable-Rate Mortgages (ARM)

Interest rate of ARM fluctuates with level of current interest rates.

Initial Rate—”teaser rate”—low for only a short time period then adjusted upward.

Interest rate index—rates on ARMs are tied to an index not controlled by the lender, such as 6- or 12-month U.S. Treasuries.

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Adjustable-Rate Mortgages

Margin – the amount over the index rate that the ARM is set.

Adjustment Interval – how frequently the rate can be reset.

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Adjustable-Rate Mortgages

Payment Cap – sets dollar limit on how much the monthly payment can increase during any adjustment period. If interest rates go up, the monthly

payment may be too small to cover the interest due—negative amortization.

Unpaid interest is added to the unpaid loan balance, increasing its size.

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Adjustable-Rate MortgagesARM Innovations:

Convertible ARM—to fixed-rate loan

Reduction-option ARM—one time opportunity to adjust interest rate.

Two-step ARM—combined aspects of fixed-rate and ARM.

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Adjustable-Rate VersusFixed-Rate Mortgages

ARMs:low interest rate in early years.can get larger loan because PITI is lower.reset interest rates push ARM payments

upward

Fixed-rate mortgages:In general, fixed-rate better than ARM.Payments never change.Allows for control and planning.

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Specialty Mortgage Loan Options

Balloon Payment Mortgage Loan – small monthly payments for 5-7 years, then entire loan due.

Graduated Payment Mortgage – payments set in advance, rising for 5-10 years, then level off.

Growing Equity Mortgage – designed to let homebuyer pay off mortgage early.

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Shared Appreciation Mortgage – borrower receives below-market interest rate, lender receives a portion of future appreciation.

Interest Only Mortgage – interest only payment for initial set period, then pay both interest and principal for remainder of loan.

Specialty Mortgage Loan Options

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Option Payment ARM Mortgages – can make different types of mortgage payments each month

Options include:Amount less than interest dueInterest only Payment amount of 150- or 30-year

fixed-rate loan

Specialty Mortgage Loan Options

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Big jump in monthly payments if interest rates rise

Read fine print.

Know how much your monthly payment could increase, when, and whether you could afford them

Penalties

Risks Associated with Specialty Mortgages

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Beware of Subprime Mortgages and Predatory Lending

Subprime mortgages—mortgages taken out by borrowers with low credit scores.

Predatory lenders take advantage of these lenders.

Abusive loans—high-cost loans with little chance of paying off

Avoid predatory loans with knowledge.

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Mortgage Decisions: Length or Term of the Loan

15- or 30-year maturity on mortgage?

Prepayment opportunities

Size of monthly payment

Interest rate

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Smart Buying in Action: HousingComing up with the down payment

Save, gifts from family and friendsAt least 5% of closing costs have to

come from homebuyer“Gift letter”

Private Mortgage Insurance

Prequalifying—have maximum amount you’ll qualify for confirmed by a lender

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Smart Buying in Action: HousingStep 3:Make Your PurchaseComparison shop

Traditional real estate agent

Independent or exclusive buyer-broker

Get it inspected

Make an offer and haggle

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Smart Buying in Action: HousingContract

Earnest money

Closing

Settlement or closing statement

Step 4: Maintain Your PurchaseRefinancing

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SummarySeparate needs from wants, compare products,

negotiate, maintain product, and resolve complaints.

Lease or buy a vehicle that fits both your personal and financial needs.

Choose housing that meets your needs, preshop, comparison shop home and financing, and maintain if your purchase.

Get the most out of your mortgage.

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